German Inheritance and Gift Tax Reform 2009

Diplomarbeit von Carolin Braun

Introduction:

Background and Subject of this Thesis:

After long negotiations within the Grand Coalition (Große Koalition) and despite jurisdictional criticisms of numerous points, on 31st December 2008 the new inheritance and gift tax law (Erbschaftsteuerreformgesetz - ErbStRG) was published in the Federal Law Gazette (Bundesgesetzblatt), to become effective on 1st January 2009 – just in time to avoid the need for retroactive regulations and the related discussions.

This marks the end of the discussion about the future of the inheritance tax that has been started by the decision of the Federal Constitutional Court (Bundesverfassungsgericht - BVerfG) from 7th November 2006. The related uncertainity came to an end, at least for now.

In its decision the Federal Constitutional Court states, that the discrepance between fair market value and valuation value for significant groups of assets (business assets, portions of coporations, real estate property and agriculture and forestry (AF) businesses) are violating the principle of equality of § 3 sec. 1 of the German Basic Law (Grundgesetz - GG). The legislative was obliged to define a new legislation in line with the constitution until 31 December 2008, latest.

On 11 December 2007, the German Federal Government (Bundesregierung) finally agreed on a draft revision of the inheritance and gift tax law and the valuation law. The German Federal Parliament (Bundestag) passed the inheritance tax reform on 27 November 2008 in the 2nd and 3rd reading, during which the finance committee of the German Parliament (Finanzausschuss des Bundestages) made considerable changes to the original draft.

The approval in the German Federal Council (Bundesrat) was obtained in the special session of the council on 5.12.2008, the approval of the Federal President (Bundespräsident) on 24.12.2008.

Current Situation:

In addition to the changes necessary for constitutional reasons, the central concern of the reform is to simplify business takeover by the successors. However, the legislator neither has had the courage to - as hoped by many - completely abolish inheritance taxation, not did he take the opportunity to perform a complete change of the inheritance taxation system which might become mandatory for constitutional reasons. The result is a compromise between of the various government parties: a law that amends the existing inheritance tax law on which it is based in a limited number of points.

The new inheritance and gift tax law poses a variety of new requirements to the tax consultants: unlike before, preferential treatment for the transition of business assets can often only be realized if carefully prepared. This becomes even more important, because the new tax valuation increases the tax risk significantly. On the other hand, the new legislation allows for more freedom to tailor the taxation of transferred assets than recognised in the public debate. Partially this freedom is due to shortfalls in the new law, and future amendments to correct these can be expected.

The ongoing and increasing - in some cases controversial - criticisms of the newinheritance tax law and valuation law by representatives of economics, consultants, auditing and various lobbies underlines the importance of the matter of burden effects on the transfer of business assets.

Aim of this Thesis:

The primary aim and focus of this work is to give an overview over the new inheritance and gift tax laws as well as on the innovations of the corresponding valuation law. The resulting consequences of the inheritance tax burden on the transfer of business assets shall be presented in detail and numerous examples shall illustrated the practical application.

Explanation of Approach:

First, in Chapter 2, the development of the law reform is summarized. The following Chapter 3 presents a brief overview of the temporal scope of the reform. The presentation of the changes effected by the reform of the valuation law is given in Chapter 4. The most significant changes of the ErbStRG with respect to bases and rates of the inheritance taxation are explained in Chapter 5 in conjunction with the new preferential treatment regulations, the total wages and salaries regulation and the clause introducing holding regulations. Then, in Chapter 6, as embedded into examples illustrating how to deal with the new regulations in practice, issues are highlighted with which taxpayers and consultants will be confronted during the tailoring the transfer of assets.

Note that the content of chapter 6 is presented in the German version only.

Finally, in Chapter 7 the main results are summarized in a conclusion and a brief outlook on possible future developments is given.

Table of Contents:

	Preface to the English Version of this Thesis	I
	Table of Contents	II
	List of Figures	V
	List of Abbreviations	0
1.	Background and Subject of this Thesis	2
1.1	Current Situation	2
1.2	Aim of this Thesis	3
1.3	Explanation of Approach	3
2.	Evolution of the Legislation	4
2.1	Constitutional Framework	4
2.2	Decision of the BVerfG on 22 June 1995	4
2.3	Decision of the BVerfG on 7 November 2006	5
2.4	The Passed Bill	6
3.	Chonology of Applicable Regulations	7
3.1	General Applicability	7
3.2	Issue of Retroactive Effectivity	7
3.3	Revokement and Cancelation Clauses	8
4.	Reform of the Valuation Tax Act 2009	9
4.1	Overview	9
4.2	Valuation of the Business Assets	10
4.2.1	Definition of the Term of Business Assets	10
4.2.1.1	Economic Unit	10
4.2.1.2	Perimeter of the Business Assets	10
4.2.2	Simplified Capitalized Earnings Value Method (§ 200 BewG)	11
4.2.2.1	Sustainably Achievable Annual Revenue (§ 201 BewG)	13
4.2.2.2	Operating Result (§ 202 BewG)	13
4.2.2.3	Factor of Capitalization (§ 203 BewG)	14
4.2.3	The Minimum Value	14
4.3	Valuation of Shares in Corporations	15
4.3.1	General Valuation Principles	15
4.3.2	Derivation from Trading Transactions	16
4.3.3	Capitalized Earnings Value Method	16
4.3.4	Valuation of Shares in Corporations not Quoted	16
4.3.5	Amount of Business Assets of a Corporation	17
4.4	Valuation of Real Estate Property	17
4.4.1	General Valuation Principles	17
4.4.2	Valuation of Undeveloped Real Estate	18
4.4.3	Valuation of Developed Real Estate	19
4.4.3.1	Comparison Value Method	20
4.4.3.2	Capitalized Earnings Value Method	21
4.4.3.3	Tangible Asset Value Method	21
4.5	Valuation of Agriculture and Forestry Assets	23
4.5.1	Definition of Agriculture and Forestry Assets	23
4.5.2	Fair Market Value for Operating Units	23
4.5.3	Valuation	23
4.5.3.1	Determination of the Continuation Value	24
4.5.3.2	Minimun Value for Small-sized and Midium-sized Enterprises	24
4.5.3.3	Liquidation Value	25
5.	Reform of the Inheritance and Gift Tax Act 2009	26
5.1	Overview	26
5.2	New Free Allowances	26
5.2.1	Personal Free Allowances (§ 16 ErbStG)	26
5.2.2	Free Allowances for Tangible Property (§ 13 ErbStG)	28
5.3	New Tax Rates (§ 19 ErbStG)	29
5.4	Rules for Preferential Treatment	30
5.4.1	Assets Qualified for Preferential Treatment (§ 13b sec. 1 ErbStG)	30
5.4.2	Business Assets (§ 13b sec. 1 no. 2 ErbStG)	31
5.5	Prefrential Treatment Regulations	31
5.5.1	Preferential Treatment Models (§ 13a ErbStG)	32
5.5.1.1	Standard Preferential Treatment (§ 13a sec. 1-7 ErbStG): Deduction for 85%	32
5.5.1.2	Total Exemption: Preferential Treatment Deduction for 100% (§ 13a sec. 8 ErbStG)	33
5.5.2	’Moving’ Tax Allowance (§ 13b sec. 4 ErbStG)	34
5.5.3	Melting Regulation (§ 13a sec. 2 sentence 2 ErbStG)	34
5.6	Operative Assets for Tax Purposes	35
5.6.1	Determination of the Portion of the Operative Assets for Tax Purposes (§ 13b sec. 2 sentence 3-4 ErbStG)	35
5.6.2	’Young ‘ Operative Assets for Tax Purposes	36
5.7	Total Wages Regulation	37
5.7.1	Definition of the Total Wages Regulation (§ 13a sec. 4 ErbStG)	37
5.7.2	Base Total Wages and Salaries (§ 13a sec. 1 sentence 3 ErbStG)	37
5.8	Holding Regulations (§ 13a sec. 5 ErbStG)	38
5.9	Retroactive Taxation	39
5.9.1	Violation of the Total Wages and Salaries Clause	39
5.9.2	Violation of the Regualtions for Holding	40
5.9.2.1	Payment of Time-Proportional of Additional Tax (Principle)	41
5.9.2.2	Payment of Full-Extent Payment of Additional Tax (Total Exception)	41
5.9.3	Coincidence of Violation of the Holding Regulations and Total Wages and Salaries Violation	42
6.	Effects and Calculations on Organisation Practice during the Transmission of Business Assets	43
7.	Conclusion and Outlook	44
	APPENDIX: Figures	46
	List of Case Law	85
	Glossary English – German	86
	Glossary German – English	90

Text Sample:

Valuation of Agriculture and Forestry Assets:

Definition of Agriculture and Forestry Assets:

According to § 158 sec. 3 BewG, agriculture and forestry (AF) assets comprise all economic goods that continuously serve a business of agriculture or forestry in the sense § 158 sec. 1 of the BewG. Here, their purpose at the time of taxation is decisive (§ 161 BewG). In particular they include ground and land as well as buildings, the so-called standing operational assets, the normal inventory of circulating operational assets, and the immaterial business assets. For the valuation the affiliation of the individual business assets to this kind of ‘agriculture and forestry assets”. The type of business of the agriculture and forestry is defined in § 160 BewG.

Fair Market Value for Operating Units:

It is new that for inheritance taxation purposes starting from 2009 the liabilities in economic relation to AF assets belong to the AF assets (§ 158 sec. 5 BewG). The intention is a valuation by the fair market value (§ 162 sec. 1 BewG). According to the legal definition the fiscal value for the inheritance taxation purposes is represented by the fair market value according to §§ 162-166 BewG.

So far commitments counted amounting to the private possession. It is reached by the allocation to the LuF assets that for an economical unit of the LuF asset by balancing the fiscal net acquisition can be determined. The composition of the value of an enterprise of the land and forestry regulates § 168 sec. 1 BewG. Contrary to the past valuation is the value land and forestry ‘a net value ‘.

Before, so far liabilities were accounted normally to the private asset fortune. By assigning them to the AF assets, balancing can yield the fiscal net acquisition. The composition of the value of an AF business is regulated by § 168 sec. 1 BewG. Contrary to the past valuation, the value of AF assets is a net-value. So far, the principles of mixed gifts were applicable in the case of the transfer of liabilities of an AF business in the form of a gift. Mixed gifts are presented in future only if the transfer of AF assets also comprises private obligations, e.g. support obligations.

The legislator assumes that the acquirer continues the AF business, i.e. not the fictitious value for realisation in the sense of § 9 BewG, but a continuation value understood as the fair market value. If the enterprise is not continued, the fair market value to be set is to be evaluated later in a different way and a so-called liquidation value in accordance with § 166 BewG shall be applied.

Valuation:

For the determination of the fair market value of the operational parts of the agriculture and forestry assets, the productive AF areas, the subsidiary assets, as well as mining-, useless and nearly useless aeras must be assessed separately, usually by their economic value, in accordance with § 163 BewG (continuation value).

The total economic value of the agriculture and forestry results then in accordance with §§ 163, 164 BewG from the sum of the economic values of the individual parts of the business. This sum is limited downwards by the minimum value and upwards by the verified market value in accordance with § 165 sec. 2 BewG. If the AF enterprise or substantial operating bases are sold, withdrawn, or similar, within 15 years, then the liquidation value in accordance with § 166 BewG replaces retroactively the value determined according to §§ 163 - 165 BewG.

Determination of the Continuation Value:

The continuation value is determined in a typified net capitalized earning value method on the basis of the average net profits per agriculturally used area with a capitalization factor of 18.6 (§§ 165 in conjunction with § 163 BewG). In the opinion of Halaczinsky/Riedel, leased areas should to be included into this value. The net profit specified in § 163 BewG is not an individual net profit, but the net profit respectively net profit factor determined according to the valuation law and the attachments 14 - 20 BewG.

§§ 163 sec. 2pp prescribe how the net profit shall be determined. The net profit that can be applied depends in accordance with § 163 sec.3 and 4 BewG on the type and size of the business. The size of business results from the standard profit margin divided by 1,200 EUR.

Example: Continuation Value:

A large-scale business (agriculture) in the sense of § 163 sec. 3 BewG in the region of Magdeburg, here 180 EGE, has a net profit of 107 EUR/ha following attachment 14 column 4 BewG. In the case of 200 ha a capitalised net profit of 107 EUR x 200 x 18.6 = 398,040 EUR would be obtained.

Minimun Value for Small-sized and Midium-sized Enterprises:

A medium-sized enterprises, that yield only small or negative net profits, a minimum economic value must be assigned for fiscal purposes (§ 164 BewG). The minimum value is obtained from the value of the ground and the value of remaining economic goods, each capitalised with 18,6.

Example: Minimum Value:

A medium-sized business (agriculture) in the sense of § 163 sec. 3 BewG in the region of Magdeburg is assumed to have 80 EGE and an agriculturally used area of 80 ha. According to attachment 14 column 4 BewG the net profit was -22 EUR/ha, thus a clearly negative net profit. Therefore, in this case the minimum value is to be applied in accordance with § 164 BewG. The land value is accounted as 100 EUR x 80 = 8,000 EUR plus a plant capital of 77 EUR x 80 = 6,160 = 14,160 EUR x 18.6 = 263,376 EUR (intermediate) minimum economic value.

Liquidation Value:

If an AF business or a share of it in the sense of § 158 sec. 2 sentence 2 BewG is sold within less than 15 years after the comparison date of the valuation, the valuation of the business unit is performed deviating from §§ 163, 164 BewG by applying the liquidation value as in § 166 BewG.